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Tuesday, December 4, 2012

Bailouts Without Stimulus: E.U. Policy on Spanish Banks

Directly and indirectly, the housing bust that began in 2007
put “the bailout” on the map in the lexicon of industrial policy both in Europe
and North America. Whereas in the U.S., few restrictions were placed on the
recipients, the E.U.’s first €37 billion ($47.9 billion) for Spain’s banking
sector required the four major state banks “to make sharp cuts in their balance
sheets and payrolls,” according to the Wall Street Journal. Bankia, the largest
of the banks to be bailed out, planned to cut its number of employees by more
than 6,000, close more than 1,000 branches, pass on any further real-estate
lending, and reduce its assets by €50 billion as the bank focuses on retail
banking—getting back to the knitting, as it were. Presumably the bankers were
not allowed to grant themselves bonuses as a condition of the bailout. If so,
it would differ appreciably from the U.S. bailout of Wall Street banks.

Avoiding the pitfalls of rewarding banks in trouble with
black checks is one thing, however; seeing to it that the downsizing does not
hamper the lending market itself is quite another. E.U. officials may have
dropped the ball in this regard. At the time, banks based in Spain had a total
of €1.7 trillion in outstanding loans, down from a peak of more than €1.8 trillion.
A further fall of €300 billion was expected as a result of the cutbacks at the
bailed-out banks.

The IMF, a technical adviser on the bailout, suggested that
state officials in Spain “must make sure the downsizing . . . can be
compensated by expanding lending by other banks.” It is doubtful, however, that
the beleaguered state was in any position at the time to stimulate lending by
other banks—particularly given that monetary policy was set by the European
Central Bank and Spain itself was incurring deficits amid a high unemployment
rate.After all, the bailout funds were
coming from the E.U. That the €37 billion was only the first piece of a €100
billion “rescue line of credit for Spanish banks” suggests that more could have
been done by the E.U. to encourage smaller,
more stable banks in Spain to increase their
lending. That in turn could have expanded economic output in the state—a worthy
goal given that people under 25 faced a 50% unemployment rate at the time in
Spain.

Likewise, the TARP program in the U.S. could have given just
enough to the big banks to keep them from following Lehman Brothers (i.e., to
stop the conflation enabled by short-sellers), while demanding that those banks
downsize. At the very least, being too big to fail would have been reason
enough for that policy (plus a cap on bonuses). The disbursement of TARP funds
to smaller banks sufficiently solid financially that the funds could serve as a
fertilizer of sorts for reasonable (not
explosive) growth could have
facilitated a basic shift. That is to say, the biggies could have been
contracting as the “next generation” was being helped along to take up the
slack. The resulting credit in the economy would have acted as a stimulus to
economic activity (hence reducing unemployment).

In short, “bailout” could have been viewed both in the E.U.
and U.S. as only part of the equation to be applied to trouble-spots in the
economy. By analogy, a person can facilitate weight-loss by adding an exercise
regime (and a stimulating diet of fruits and vegetables) to cutting the total
number of calories ingested. A viable industrial policy favors bright spots
while managing problem-children in such a way that their activity is restricted
rather than rewarded. This may be one of the principal lessons coming out of
the housing bust that began in 2007.